ECONOMIC RETURNS TO HIGHER EDUCATION

PREPARED BY-
Dr. MANISHA RANI, ASSISTANT PROFESSOR, DES
MAHATMA GANDHI CENTRAL UNIVERSITY, MOTIHARI, BIHAR
Learning objectives

• Understand the basic concept of economic returns to higher education.

• Differentiate between various kinds of educational returns.
• Understand the measurement techniques of educational returns
• Know the associated Signaling and Human Capital theories
Introduction

• Monetary benefits from education are called as returns.

• It is the ratio of money gained or lost (whether realized or unrealized) on an investment
relative to thei amount of money invested.
Types of returns-

• Private returns- The benefits accruing to an individual .

• Social returns- The sum of all private returns together with the taxes on income paid
by individuals .
Private rates of return are higher than social returns. This is because of the public
subsidization of education and the fact that typical social rate of return estimates are not
able to include social benefits..
 Private returns to higher education-

Pecuniary (Monetary)

BENEFITS COSTS
• Increased wages • Tuition fees
• Fringe benefits and pensions • Books and study materials
• Reduced unemployment risks • Forgone labor income
 Continued….

Non-Pecuniary (Non- Monetary)

Intended Unintended
• Networking • Improved health
• Cultural capital • Better family planning
• Pleasure of student life etc. • Marriage stability
 Social returns to higher education

BENEFITS COSTS
• Crime reduction
• Crowding out of other services
• Improved health
• Loss of labour while in education
• Knowledge spill-over and growth
• Direct costs of education
• Environmental goals
The benefits or returns of education

1) Direct Benefits of Education - the direct benefits of education are those benefits of
education (or returns from education) which are realized directly by the students. They are
of following three types:
a) Direct returns
b) 'Financial option' returns; and
c) Non-Monetary returns.
Continued….

2) Indirect or External Benefits of Education - any investment in education gives

rise to many benefits which are often not so visible and are indirect.
• These benefits are not appropriate or captured by the parents and students making
investments in one's schooling.
• Some such benefits of education accrue to 'other' individuals and the society at large. All
such benefits (which accrue to other than those who actually make investments are
education) are called as the 'external benefits' of education.
Calculation of returns-

Two techniques are followed to calculate rates of return to different levels and forms of
education. They are:
• The Net Present Value (NPV) technique and
• The Internal Rate of Return (IRR) technique.
Continued…..

• Net present value (NPV) - is used in Capital budgeting to analyze the profitability of
a project or investment. It is calculated by taking the difference between the present
value of cash inflows and present value of cash outflows over a period. Formula for NPV-

Formula for NPV

NPV = (Cash flows)/( 1+r)i
i- Initial Investment
Cash flows= Cash flows in the time period
r = Discount rate
i = time period
 Continued….

• The internal rate of return (IRR) - is a discounting cash flow technique which gives
a rate of return earned by a project. The internal rate of return is the discounting rate
where the total of initial cash outlay and discounted cash inflows are equal to zero. In
other words, it is the discounting rate at which the net present value(NPV) is equal to
zero.
Theories-

(1) Signaling theory- claims that education raises wages simply because education levels
is a signal of the workers ability (unobserved by the employer).
• Signaling in education suggests productivity is independent of education, but education
acts as a credential for greater ability.
 Example

• In other words, if we are able to get good A levels and get a degree from a respected
university, then a firm will have evidence that we have certain valuable skills, such as the
ability to learn and write. Therefore, we are more likely to get a highly paid job. However,
the education might not actually increase our labor productivity, but only show we have
the capacity to be an able worker. For example, a degree in ancient Greek may never be
used in your job as an accountant. In this case, the only function of higher education is
signaling your ability.
Continued….

Limits of Signaling
• Signaling is not the only function of higher education. Clearly some degrees play a key
role in training a workforce to have higher labor productivity. For professions such as
research scientists, teaching, doctors, and medicine, a degree is indispensable, to claim it is
only a signal would miss some skills that taking a degree can teach.
Continued-

(2) Human capital theory –The idea of human capital theory is often credited to the
“founding father of economics” Adam Smith, who in 1776, called it “the acquired and useful
abilities of all the inhabitants or members of the society.”
• It claims that education raises wages by increasing productivity. It focuses on how
education increases productivity and efficiency of workers by means of increasing the
level of cognitive stock of economically productive human capability which is product of
innate abilities and investment on human beings.
Example

• For example, some countries offer their people a free college education out of a
realization that a more highly educated populace tends to earn more and spend more,
thus stimulating the economy. In the field of business administration, human capital theory
is an extension of human resources management.
Limitations of human capital theory-

• It provides little insight into the processes through which education and training are
translated into higher wages. In statistical models, education and training account for
about 30 percent of the variance in individual wages, which suggests HCT leaves a
significant percentage of wage variability unexplained.
Continued…….

• A related limitation is that upper-level applications of HCT (e.g., at the national or state
levels) treat education as a relatively homogenous input. These applications assume that
higher levels of educational attainment and quality will yield greater productivity and
wages across the board. Such treatment of education is problematic because the process
of human capital formation varies for individuals and groups. People learn differently, and
a “quality” education in one context may prove ineffective in another.
Self assessment-

• What do you mean by returns ?

• Differentiate between direct and indirect benefits or returns of education.
• What are the techniques for calculating returns?
• Define Human Capital theory.
• How Signaling theory is different from Human capital theory?
 References

• http://egyankosh.ac.in/bitstream/123456789/23272/1/Unit-14.pdf
• http://archive.mu.ac.in/myweb_test/ma%20edu/M[1].A._EDU_ECONOMICS_OF_EDU.-Final_1_2011-12.pdf
• https://medium.com/@nidhitambi/relevance-of-human-capital-theory-and-signalling-theory-of-education-in-the-indian-context-4141bd44206d
• https://www.economicshelp.org/blog/2498/education/signalling-in-education/
• https://www.thoughtco.com/human-capital-definition-examples-4582638
• https://www.tandfonline.com/doi/abs/10.1080/00086495.2013.11672495?needAccess=true&journalCode=rcbq20
• https://cleartax.in/s/npv-net-present-value
• https://education.stateuniversity.com/pages/1930/Economic-Benefits-Education-Investment-Measurement.html
• http://egyankosh.ac.in/handle/123456789/8307
• https://www.researchgate.net/figure/The-private-and-social-returns-to-higher-education_fig1_45138150
• https://blog.uvm.edu/cessphd/2016/01/19/the-strengths-and-limitations-of-human-capital-theory-in-educational-research-and-policymaking/
Thank You